First of all it seems highly unlikely that the US will actually “go over the cliff” and see all of these things happen.  By most reports, negotiations between President Obama, Speaker Boehner, and the other leaders of the US Congress have been productive and amicable.  Still, even if we have a deal, it most likely will include both revenue increases for the government (in the form of tax increases and/or eliminating deductions) and spending cuts (which could very well include changes in such sacred cows as Medicare and Social Security as these are by far the largest drivers of the long term deficit).

In the summer of 2010, leaders imposed mandatory spending cuts to take place after the 2012 election in order to get a deal on raising the debt ceiling.  This conflict nearly triggered a US default on its debt, and did cause the first ever downgrading of US bonds from AAA. Also, way back in the Bush administration, in order to get the giant tax cuts through Congress, they were written as temporary, eventually they were expanded in early 2010, and now are set for expiry in 10 years at the end of 2012.   So, if Congress does not act, through somewhat sheer folly and chance, we will face both huge reductions in government spending and huge increases in taxes.  This could have a significant drag on GDP and plunge a weak recovery back into recession.  If you want to be really scared, look over at Europe as the cliff will essentially act like the austerity programs in Britain, Greece, and Spain which have caused deep recessions and much suffering.

So, this should be the biggest concern, if we actually go over the cliff we will likely have a recession with all of the damage that implies to employment, consumer confidence, and social fallout.  Who knows exactly how everyone might be affected by that, but affected we will be.  Already, many businesses report not hiring or investing for fear of the cliff and what it could do to the economy and the business atmosphere.

More specifically, the tax cuts will affect you differently depending on your income.  Here is chart showing the damage on your wallet from the Tax Policy Center:

Clearly, this is enormous.  However before anyone over $108,000 panics too much, since this is an average amount and there is a wide range of incomes over 108k, it is not quite as stark as it may seem.  Those making over $2M for example, could see a $640,000 increase, according to CNN.  This works on a sliding scale so those closer to $108K should see an increase more like the $4-5,000 range.

But, we probably won’t go over the cliff.  Therefore, its biggest impact could include limiting or eliminating time honored deductions like the mortgage interest deduction. Many reports believe this is widely being discussed in negotiations.

Seniors could be most affected as they would face double barrel damage of higher taxes and cuts or changes to Medicare and Social Security.  This also really seems to be on the table.  Also, with the fallout over the rich paying such low taxes on investment returns and dividends, seniors who depend on dividend payments for income could  take a hit there too.

At the end of the day, the fiscal cliff falls into a Rumsfeldian “known unkown” category as we just don’t know what will happen or what a deal will look like to avoid it.  You can bet your dollar (which you may not want to do as you’ll probably be missing some anyway) that we will enter an environment with modestly higher taxes on those making over at least $250k and maybe those making something less than that too.  We will probably also see some changes to Social Security and Medicare, hopefully timed not too badly hurt those already in the program or near it.

Keep an eye on things though, as there are a lot of myths and poor information. The issue is even so delicate that what might seem like cost savers, like raising Medicare age, might actually hurt the system as younger seniors are not usually the ones driving up costs.  In fact their presence could be what keeps costs down.

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Related Resources:

1. Moving Towards the Fiscal Cliff
2. Is the Fiscal Cliff Deal a Good Thing?
3. Fiscal Cliff: We Have the Politicians We Deserve
4. The Old and Wealthy Pay in Fiscal Cliff Deal
5. The Fiscal Cliff Deal: The Impact of Increasing Revenues
6. The US Constitution and the Debt Ceiling Limit
7. Your MacroWallet: Politics and Housing